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Speech by SEC Staff:
Remarks Before the 2008 AICPA National Conference on Current SEC and PCAOB Developments


Mark Mahar

Associate Chief Accountant, Office of the Chief Accountant
U.S. Securities and Exchange Commission

Washington, D.C.
December 8, 2008

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author's colleagues upon the staff of the Commission.


During this session, I intend to cover two broad areas. First, I will continue what has become an annual discussion of materiality. Next, I will touch on the interaction of the Commission’s proposed revisions to the oil and gas disclosure requirements with the IASB’s current project contemplating all extractive industries.

Materiality and SABs 99 and 108

Staff Accounting Bulletin No. 108 (SAB 108): Before I begin this dive into the conceptual world of materiality, I want to clarify an important point about the effect the method of quantifying an error has on assessing the materiality of an error existing in previously filed financial statements. Question 1 of SAB 108 addresses a circumstance where, during the course of preparing its financial statements, a registrant discovers an improper $100 expense accrual which has built up at a rate of $20 per year over the course of the previous 5 years, inclusive of the Year 5 financial statements currently being prepared.

Let us assume that the error existing on each balance sheet and income statement is not material, quantitatively or qualitatively, to any of the previous Years 1 through 4. However, correcting the cumulative $100 balance sheet error in Year 5 would introduce an $801 error in the Year 5 income statement which would materially misstate Year 5.

In that circumstance, SAB 108 indicates the “prior year financial statements should be corrected even though such revision previously was and continues to be immaterial to the prior year financial statements.” However, the response also notes that “correcting prior year financial statements for immaterial errors would not require previously filed reports to be amended.” Said another way, if a restatement of previously issued financial statements is required, but such restatement would not result in the previous year financial statements changing materially, than the company can restate those financial statements the next time they are presented without amendment to the previous filings or the issuance of an Item 4-02 8-K.

In evaluating whether the Year 2, 3 or 4 financial statements are materially misstated, we understand that some look to the response in Question 2. That response states that a “separate analysis of the financial statements of the prior year (and any other prior year in which previously undiscovered errors existed) would need to be performed to determine whether such prior year financial statements were materially misstated” (emphasis added). Despite the guidance, some registrants and auditors have interpreted this to mean that when evaluating Years 2, 3 or 4 separately, if the effect of correcting the error that exists in each balance sheet2 materially impacts the income statement of each year, then the registrant must amend those previously filed financial statements.

This is not how the staff applies SAB 108. The discovery of a material error generally requires restatement consistent with SFAS No. 154.3 However, SAB 108 contemplated that in some circumstances restatements could be included in a company’s next filing rather than via an amendment to the previous filing or filings when the effect of restating the previously issued financial statements does not result in a material change to those financial statements.

Using my example, recall that the balance sheet and income statement affect of the error is not material to any given period however an out of period correction of the cumulative balance sheet error in any particular year might have been material. If that is true, then the restatements would not materially alter the previous financial statements, as reported, and therefore those financial statements could still be relied upon. Therefore, the registrant could include the restatement with the next filing4 without amending the previous filings.

Committee on Improvements to Financial Reporting (CIFiR) and SAB 99: While there are issues and challenges on how to correct an error – the hard question frequently is: Is the error material?

To that end, let’s move forward by considering the past. Since the issuance of SAB 99, we have highlighted a number of circumstances involving the discovery of errors existing in previously issued financial statements that companies, auditors and users have struggled over. So for those of you watching at home, let’s recap:

In 2004 through 2006 we continued the conversation on quantifying errors. In 2006 and 2007, we discussed the narrow issues of whether a ‘large’ error might be considered immaterial and whether it is appropriate to net certain errors. We also touched on materiality assessments relative to interim periods and emphasized the importance of considering the total mix of information and views of the reasonable investor.

Flash forward to 2008. We have received significant feedback from financial statement users, auditors and preparers, most notably in the form of CIFiR wich spent considerable time focusing broadly on materiality. CIFiR’s recommendations5 included emphasizing the fundamental premise that materiality is founded upon consideration of the total mix of information from the perspective of the reasonable investor and therefore those who judge the materiality of errors should do so with that premise in mind.

CIFiR notions are consistent with our discussions of the last four years. Further they are consistent with the Supreme Court’s view6 that the concept of the total mix of information applies regardless of the magnitude of error. Although relative magnitude is itself a factor and may provide a basis for a preliminary view, the staff does not exclusively rely on numerical or percentage based bright-lines.

The staff does appreciate that materiality decisions necessarily involve the use of judgment. Specific to this circumstance, judgment includes developing a robust analysis that steps into the investors’ shoes, identifying what is significant to investors’ decisions and should not be limited to the factors provided in SAB 99 because those factors are neither exhaustive nor intended to preclude conclusions that quantitatively larger errors may be considered not material. Rather, evaluators of materiality should consider the relevant information considered important to investors which may include non-SAB 99 specified circumstances ….when I say such as, let us be clear there could be other circumstances, so such as considering:

  • company specific trends and performance metrics that may influence investment decisions; or
  • when a factor important to a reasonable investor is impacted by an unrelated circumstance. For example, when an error in the income statement is magnified simply by occurring during a period in which net income is abnormally small as compared to historical and expected future trends.

If consideration of the total mix of information and how a reasonable investor might consider such information is the premise of materiality evaluations, then whether an error appears within annual or interim financial information should not alter that premise. Rather, each error should be evaluated in light of the surrounding circumstances as a reasonable investor would. The same effort to identify and evaluate the relevant information in annual financial information should be applied to interim financial information, appreciating that the relevant information for annual and interim periods may not always be the same.

In summary, when assessing materiality in any set of financial statements, evaluating whether an error is material necessarily depends on identifying and considering investor concerns and the relevant circumstances, i.e. the total mix of information and should not focus on magnitude alone. This objective also recognizes that certain circumstances may differ depending on the company, industry or even the period covered by the financial statements under evaluation.

Interaction with the International Accounting Standards Board (IASB) and the SEC’s Updates to its Oil and Gas Disclosure Requirements: Next, I will take a moment to address conceptual regulatory concerns raised by some including other standard setters and regulators regarding the SEC’s proposed changes to its oil and gas disclosure requirements.

As many in the mining and oil and gas industry are probably aware, the IASB currently has a research project to develop a comprehensive accounting and disclosure standard that could potentially be applied to all extractive orientated companies including oil, gas and mining companies. Those who have expressed concern appear to appreciate recent momentum to move towards converged accounting standards and ultimately towards a single set of high quality accounting standards. Therefore, they have suggested the timing of the SEC proposed rule to be perhaps peculiar.

The most succinct way to address those comments would be to highlight the on-going interaction between the IASB and the SEC staff. First, the SEC staff has an official observer to the IASB’s working group and has been following the project closely for over 3 years, including participating in a recent board member education session. This interaction has allowed the staff to appreciate the breadth, depth and timing differences between the two projects. The breadth of the IASB’s project includes researching potential new accounting and disclosure requirements. The SEC’s proposed rule is primarily limited to updating current disclosure requirements. The depth of the IASB’s project broadly considers all mining, oil and gas activities. The SEC’s proposed rules continue to be limited to oil and gas activities. Finally the IASB’s project is a long term project. A discussion paper is expected soon, while a final standard may not be completed until perhaps 2013 or later. The SEC’s proposed rules are intended to provide near term improvements to the current requirements which have not been substantially updated in over 25 years.

Through our continued interaction with the IASB staff, we also understand that any potential implementation of an SEC rule, including the reactions from investors, will be monitored by the IASB staff as part of their continuing research into eventually developing a comprehensive accounting and disclosure model. Therefore, we believe the interaction between the staff has been mutually beneficial to both the IASB’s project and the SEC’s proposed rule development. We have appreciated the feedback received from both the IASB and FASB staffs and all who responded to the Concept Release and Proposed Rule comment letter requests and we look forward to continued cooperation between our staff and the IASB’s and FASB’s staff.


That concludes my remarks. Thank you for your attention.




Modified: 12/08/2008